Monday Digest
Posted 17 June 2024
Still mostly sticking to the plan
Amid a cacophony of political noise, it was the Federal Reserve’s updated interest rate forecast that drove markets last week. The signal that rates would be cut just once this year was called “hawkish”, but we think it was actually more “bullish”.
First though, manifestos. Labour and the Conservatives released their policy plans this week, with markets again largely indifferent. That might sound strange, considering that UK assets have underperformed since Rishi Sunak called the July election – after a period of outperformance. But Britain’s biggest stocks are more focused on global growth, and particularly energy and commodity demand. That’s why they did well before, and not so well now. Beyond that, rate cuts from the Bank of England – expected by August at the latest – are more important for our domestic markets.
Fed cuts are equally important. Markets had been expecting two this year, but the Fed’s ‘dots plot’ revealed that officials expect to cut rates just once in 2024. This was more about acknowledging US economic strength than a hawkish preference. Recent US inflation data has been soft, but job market data two weeks ago was exceptionally strong. This strength is giving the Fed pause. Officials are sticking to the rate cut plan, just getting more realistic about how, when and to what magnitude it can be implemented.
Markets reacted well, but unevenly. Stocks are up in aggregate, but this is almost entirely down to a handful of tech stocks – again. This is a sign of a generally weakening global growth outlook. Europe has underperformed, not just because of Macron’s surprise election call but weaker Chinese demand too. In the US, smaller caps whose fate is similarly driven by general economic growth have slipped back too.
After business sentiment surveys next Friday, we will get a better sense of where the economy is heading. Following the very strong run earlier in the year, markets feel a little fragile. It has been powered by a strong run up in earnings expectations which is starting to seem questionable given the run of softer economic data. But if sentiment data is better, we could see pro-cyclical assets do well.
Macron makes an educated bet.
Emmanuel Macron shocked the world this week by calling for a snap parliamentary election at the end of this month. The French President effectively threw down the gauntlet to far-right challenger Marine Le Pen and her National Rally (RN) party, after the latter won the largest share of French votes in last week’s European parliament elections. Macron was clear about his reasoning: “I do not want to give the keys of power to the far right in 2027, so I fully accept having triggered a movement to provide clarification,”
Markets indeed want clarification, having sold off dramatically on the apparent threat of an RN-led parliament. We wrote last week that election-inspired sell-offs tend to be short-lived and can actually make for good buying opportunities. We broadly stand by that assessment in the case of France, but we would add that volatility is likely at least until the final round of voting on July 7th.
Markets’ biggest fear about a RN victory seems to be a fiscal crisis, with Macron’s finance minister warning of a “Liz Truss-style scenario”. We shouldn’t get carried away by hyperbole, though, since sectoral analysis suggests that French companies would be relatively unaffected over the medium term. The long-term is hard to work out, since it depends on what happens at the presidential election in 2027. Marcon seems to be betting that, win or lose, his chances in 2027 will be better than if he lets RN support fester. That is plausible, but a gamble.
The risk for Macron is that an RN-led parliament spends years fighting the executive at every turn and successfully blames the deadlock on him. The risk for markets is that this heightens bond volatility and increases the anti-EU sentiment in the bloc’s second-largest economy. Volatility is likely, in the short-term at least.
Peso struggles despite election continuity
Following the surprisingly large victory for Mexico’s left-wing party Morena in the June 2nd election, the Mexican peso has lost more than 10% of its value against the dollar since the election. This might sound like par for the course as far as Latin American elections go, but markets’ vote of no confidence is more complicated than it seems.
Claudia Sheinbaum, Morena’s candidate and now Mexico’s first female president, represents continuity from president Andrés Manuel López Obrador (nicknamed AMLO). Markets similarly feared AMLO when he came in six years ago, but he achieved the improbable by both pursuing socially progressive policies and staying (mostly) in the good books of international investors. The peso is stronger now than when he assumed office – even after the recent nosedive.
Markets don’t like the scale of Morena’s victory, taking the presidency, a supermajority in the House and nearly a supermajority in the Senate. This makes it likely that 18 contentious constitutional reform bills outlined by AMLO, including the removal of congressional seats and independent regulators as well as directly electing supreme court judges, will be passed. Some fear these undermine the separation of powers. Morena’s economic policies are also seen as unfriendly to international investment.
The fears are not unfounded, but we suspect they might be overblown. Sheinbaum confirmed that she will stick with the current finance minister and fiscal rules. More importantly, Mexico’s politics does little to disturb the structural case for its growth: a beneficial realignment of US trade. After years of US-China trade wars, Mexico became the US’ largest trading partner in 2023. This structural push is not going away, with anti-China sentiment a point of rare bipartisan support in Washington.
Politics on both sides of the border mean clashes with the US are likely, which arguably increases the policy risk attached to Mexican assets. But the underlying case for Mexico remains.